LAE Definition Changes

1. LAE Definition Changes Presented to the Casualty Loss Reserve Seminar September 24, 2002

2. Introduction • NAIC changed definitions of the ALE and ULE • Why am I here? • Most of what I am going to say is pretty obvious • Everyone’s different • Opinions stated here are probably not those of my employer

3. Old NAIC Definitions • ALE - Those expenses that can usually be related to specific claims • ULE - Other than ALE • Old Definition has remained since at least 1956 • Old definitions were ordained by God

4. Characteristics of ALE • We know the same thing about an ALE payment that we know about a Loss Payment • ALE payments are generally processed through the claims system. (as opposed to Payroll or Accounts Payable) • ALE often represents the claim expense payments associated with more volatile long tail and/or catastrophic claims

5. New NAIC Definitions Defense and Cost Containment Expenses • Surveillance expenses • Fixed amounts for medical cost containment expenses • Litigation management expenses • Loss adjustment expenses for participation in voluntary and involuntary market pools if reported by accident year • Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators, if working in defense of a claim, and fees or salaries for rehabilitation nurses, if such cost is not included in losses • Attorney fees incurred owing to a duty to defend, even when other coverage does not exist • The cost of engaging experts • Plus a statement: the foregoing list is not intended to be all inclusive • Surveillance expenses • Fixed amounts for medical cost containment expenses • Litigation management expenses • Loss adjustment expenses for participation in voluntary and involuntary market pools if reported by accident year • Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators, if working in defense of a claim, and fees or salaries for rehabilitation nurses, if such cost is not included in losses • Attorney fees incurred owing to a duty to defend, even when other coverage does not exist • The cost of engaging experts • Plus a statement: the foregoing list is not intended to be all inclusive

6. New NAIC Definitions Adjusting and Other Expenses • Fees of adjusters and settling agents • Loss adjustment expenses for participation in voluntary and involuntary market pools if reported by calendar year • Attorney fees incurred in the determination of coverage, including litigation between the insurer and the policyholder • Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators, if working in the capacity of an adjuster • Plus a statement: the foregoing list is not intended to be all inclusive • Fees of adjusters and settling agents • Loss adjustment expenses for participation in voluntary and involuntary market pools if reported by calendar year • Attorney fees incurred in the determination of coverage, including litigation between the insurer and the policyholder • Fees or salaries for appraisers, private investigators, hearing representatives, reinspectors and fraud investigators, if working in the capacity of an adjuster • Plus a statement: the foregoing list is not intended to be all inclusive

7. New NAIC Definitions Summary of Changes • Expenses shifting from ULE to Defense and Cost Containment • In-house Attorneys' Salaries incurred owing to a duty to defend, even when other coverage does not exist • Expenses shifting from ALE to Adjusting and Other • Outside Attorney fees incurred in the determination of coverage, including litigation between the insurer and the policyholder • Fees of independent adjusters and settling agents • Fees or salaries for outside appraisers, private investigators, hearing representatives, reinspectors and fraud investigators, if working in the capacity of an adjuster

8. Problems with new definitions • Loss Reserving • Bureau Statistical Reporting • Ratemaking • Reinsurance

9. Problems with new definitionsLoss Reserving • Accident year identification of Loss Expenses has been polluted!! • A Portion of the new Defense and Cost Containment Expenses are either not attributable to a particular claim or are allocated by claim through a procedure that is far less reliable than the arms length billing procedure of outside counsel • A Portion (Independent Adjuster Costs and Coverage Litigation) of the new Adjusting and Other Expenses could be associated with a particular claim, but now is lumped in with in-house adjusters which dominates the expense cost • While the new definition may have little effect, every place that there is an effect there is a loss of information • Does the new Definition provide more homogeneous data for reserve analysis? • If it does, is it worth the cost in terms of loss of information?

10. Problems with new definitionsLoss Reserving • Why is accident year important? • We utilize the relationship between the change in ALAE paid to projected Incurred losses by Accident Year to project ALAE reserve requirements • Every technique that I reviewed including Salzman & Resony, concerning ALE reserving utilized accident year data or in the case of Resony Creation or Report Year Data.

11. Salzmann's Corollary 2.1 The mix by age of unpaid allocated loss expenses at the end of any period is much different from the mix by age of either incurred or paid allocated loss expenses during that period Problems with new definitionsLoss Reserving Salzmann's Principle 2 Because the smaller and easier claims (which are settled faster) require proportionately less allocated loss expense, the ratio of paid allocated loss expenses to paid losses generally increases with age of development. Therefore: The age of the claim is necessary which requires the date of payment and the accident year of the claim

12. Problems with new definitionsLoss Reserving • The Southern Farm Bureau Casualty Experience • Unallocated - we look at a calendar year paid to paid ratio and a paid to the average of paid and incurred. The average is applied to the year end outstanding reserve or more accurately the year end estimated loss reserve. • Allocated - The ratio of the accident year paid ALE at each year end to the estimated ultimate accident year incurred is calculated. The marginal ratios are then calculated. Both of these are estimated using some selection after viewing the latest three year, average of last five after eliminating the high and the low. • It was found that even if there was a significant change in the ALE - ULE distribution that taking the latest year in both methods isolated the data arising since the change. Hopefully the estimated reserves arising from both methodologies were not significantly biased. In both cases the new data were isolated in the most recent Calendar Years

13. Problems with new definitionsBureau Statistical Reporting • Unallocated Loss Adjustment Expense has historically not been reported via statistical calls for data to Bureaus like ISO and NAII • Statistical Calls request data at either the detail level or at the very least by rating element. • Uses Premium data is that processed through Policy Services Systems and Loss and LAE data is that processed through claims systems. • It is unlikely that your Annual Statement Defense and Cost Containment will balance to your STAT LAE if: • You have staff litigation attorneys and their salary is not allocated by claim and then passed through the claims system. That salary will be missing from STATS, but included on the Annual Statement (in Defense and Cost Containment) or; • You still process independent adjusters and coverage litigation through the claims system and it flows through to stat calls.

14. Problems with new definitionsRatemaking • Same Balancing Problems as discussed in Bureau Reporting • Same Development Problems discussed in Reserving • Where LAE costs differ by Territory, Class, Zone, Limit loss of information can be severe • Added Costs of self billing of litigation costs, may be significant

15. Problems with new definitionsReinsurance • From reinsurer point of view • Have some of the same concerns relative to loss reserves and pricing • Should be little detrimental effect since: • Expenses included in Liability contracts are described contractually in detail • No LAE is included in property contracts • From primary company point of view • May have some detrimental impact since companies: • May no longer collect outside adjusters or (coverage determination) legal costs by claim • As a result some expenses may not be submitted to reinsurer

16. New NAIC Definitions Legal vs Adjusting Expenses • Complaint that different Companies' ALE represents differing proportion of legal and adjusting • Assumes that a primary focus of regulation is the determination of proportion of legal vs other LAE • Is this Rate Regulation, Solvency Regulation or Market Conduct? • What is the NAIC’s Agenda?

17. New NAIC Definitions Legal vs Adjusting Expenses • Assuming that determining the proportion of the premium dollar that is spent on defense litigation is a valid role of the regulator: • The endeavor should not jeopardize the other more legitimate roles namely: Rate Regulation, Solvency Regulation or Market Conduct • Measuring insurer legal costs only measures the tip of the iceberg. • What about Plaintiff attorney costs? • How much goes to the Plaintiff Attorneys is anyone's guess, but ten percent of Liability Lines is not an unreasonable estimate.

18. New NAIC Definitions Correct Method? • Where do we show line items? • Part 4 of Annual Statement and Part I of Insurance Expense Exhibit • This is where we show items like postage, printing, equipment. • We don't show ALE and ULE, nor Defense or Adjusting • This is true even on Part I of the IEE where other underwriting expenses have been broken out. • Why didn't the NAIC just break out Line 1. a. on these exhibits between Defense and Cost containment and Adjusting and Other?

19. New NAIC Definitions Correct Method? 1. Claim adjustment services a. Direct b. Reinsurance Assumed c. Reinsurance Ceded d. Total Claim adjustment services

20. New NAIC Definitions Correct Method? 1. Claim adjustment services a. Direct Defense and Cost Containment b. Direct Adjusting and Other c. Reinsurance Assumed d. Reinsurance Ceded e. Total Claim adjustment services

21. New NAIC Definitions Correct Method? 8. Salary Related Items a. Salaries b. Payroll Taxes

22. New NAIC Definitions Correct Method? 8. Salary Related Items a. Defense and Cost Containment Salaries b. Adjusting and other Salaries c. Other Salaries d. Payroll Taxes

23. New NAIC Definitions Conclusion • May be outside of the legitimate role of the NAIC • Impairs other regulatory roles especially solvency testing and data collection • Ineffective at measuring full Legal Costs • Alternative method is available that is more consistent with other Annual Statement treatment

24. What would you like to say to the NAIC?

25. Kristina’s Reaction to the Old Definition

26. Kristina’s Reaction to the New Definition

27. LAE Definition Changes Presented to the Casualty Loss Reserve Seminar September 24, 2002